Subjective theory of value

The subjective theory of value is a theory of value which advances the idea that the value of a good is not determined by any inherent property of the good, nor by the amount of labor necessary to produce the good, but instead value is determined by the importance an acting individual places on a good for the achievement of his desired ends.[1] The modern version of this theory was created independently and nearly simultaneously by William Stanley Jevons, Léon Walras, and Carl Menger in the late 19th century.[2]

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According to the subjective theory of value, voluntary trades between individuals imply that both parties to the trade subjectively perceive the goods, labour or money they receive as being of higher value to the goods, labour or money they give away. The subjective-value theory holds that one can create value simply by transferring ownership of a thing to someone who values it more highly, without necessarily modifying that thing. Where wealth is understood to refer to individuals' subjective valuation of their possessions, voluntary trades may increase the total wealth in society.[3]

Individuals will tend to obtain diminishing levels of satisfaction, or marginal utility from acquiring additional units of a good. They will initially prioritise obtaining the goods they most need, such as sufficient food, but once their need for food is satisfied up to a certain level, their desire for other goods will start to assume more relative importance, and they will seek to bring satisfaction of their need for food into satisfaction of their need for other goods.[4]

In a free market, competition between individuals seeking to trade goods they possess and services they can provide for goods they perceive as being of higher value to them results in a market equilibrium set of prices emerging.

Classical economists such as David Ricardo believed that individual people obtain different levels of utility or 'value in use' from a service, but did not effectively connect those with market prices, or 'value in exchange', seeing them as separately derived from the quantity of labour input and other production factors.[2]

Carl Menger argued that production was simply another case of the theory of marginal utility.[2] Labourers' wage-earning potential is set by the value of their work to others rather than subsistence costs, and they work because they value remuneration more highly than inactivity.[5]

Albert Einstein disagreed saying, "The economic anarchy of capitalist society as it exists today is, in my opinion, the real source of [society's] evil... The owner of the means of production is in a position to purchase the labor power of the worker. By using the means of production, the worker produces new goods which become the property of the capitalist. The essential point about this process is the relation between what the worker produces and what he is paid, both measured in terms of real value. In so far as the labor contract is "free," what the worker receives is determined not by the real value of the goods he produces, but by his minimum needs and by the capitalists' requirements for labor power in relation to the number of workers competing for jobs. It is important to understand that even in theory the payment of the worker is not determined by the value of his product."[6]

The development of the subjective theory of value was partly motivated by the need to solve the value-paradox which had puzzled many classical economists. This paradox, also referred to descriptively as the diamond-water paradox, arose when value was attributed to things such as the amount of labor that went into the production of a good or alternatively to an objective measure of the usefulness of a good. The theory that it was the amount of labor that went into producing a good that determined its value proved equally futile because someone could stumble upon the discovery of a diamond while out for a hike, for example, which would require minimal labor, but yet the diamond could still be valued higher than water.

The subjective theory of value was able to solve this paradox by realizing that value is not determined by individuals choosing between entire abstract classes of goods, such as all the water in the world versus all the diamonds in the world. Rather an acting individual is faced with the choice between definite quantities of goods, and the choice made by such an actor is determined by which good of a specified quantity will satisfy the individual's highest subjectively ranked preference, or most desired end.[7]